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Introduction to Staking
Staking refers to the process of locking up a crypto asset on a proof-of-stake (PoS) blockchain, where holders delegate their tokens to validator nodes (or become validators themselves) and receive rewards in the blockchain's native token. Staking contributes to the security of a PoS chain.
Most PoS chains are secured by economic guarantees, decentralization, and game theory. Generally, increasing the amount of stake in the protocol makes attacking/corrupting the blockchain more costly. If the correct incentives are in place, it becomes 1) increasingly less financially beneficial to act maliciously (negative expected value on an attack) and 2) increasingly less possible as only people with billions of dollars would be able to attempt the theoretical attack.
Staking as a service necessitates capital commitment, typically in the blockchain's native currency. This commitment enables participants to act as validators and oversee the production of new blocks, which are essentially data repositories for transactions.
Validators are remunerated through two main streams:
- Transaction Fees: Validators accrue fees for each new block produced, which can act as an incentive for prioritizing certain transactions.
- Block Rewards: Participating in the network's consensus mechanism and block production is incentivized through block rewards, a system designed to promote consistent validator activity.
Staking presents multiple advantages:
- Passive Income: Earn rewards over time through block rewards and transaction fees, with the yield being in the same cryptocurrency that is staked.
- Enhanced Network Security: A greater volume of staked assets translates to heightened network security by making it financially challenging to gain majority control.
- Accessibility: PoS networks lower the barriers to becoming a validator, allowing wider participation and fostering the adoption of blockchain technology.
How Staking Works
To comprehend staking's mechanics, it is essential to understand how a blockchain operates. A blockchain is a decentralized, distributed ledger that transparently and securely records and stores transactions. It is made up of a sequence of blocks that contain multiple transaction records. For a new block to be added to the chain, it must be authenticated by network participants known as validators.
Source: Xangle
In order for a decentralized network of nodes/computers to function properly, the independent participants in the network need to reach an agreement over a shared state (e.g., who owns what on a blockchain). While doing this, the network should remain fault tolerant with valid consensus despite imperfect information or malicious actors (Byzantine Fault Tolerance). Different blockchains implement different methods of doing so, but all are attempting to create a “consensus algorithm” that best fits their chain. There exist different node types in many blockchain ecosystems. Different types of nodes use data in different ways. In Ethereum, clients can run three distinct node types: light, full, and archive.
Consensus algorithms are used in public blockchain/distributed computer design in order to convince nodes in a decentralized system to agree on the next valid state. Within the context of public blockchains like Bitcoin and Ethereum, this signals that at least 51 percent of network nodes agree on the network's global state. In addition, a consensus algorithm often gives a guarantee (probabilistic or deterministic) that network nodes can reach consensus on the next valid state even if a minimum number of nodes in the system are adversarial. In Bitcoin's case, the consensus algorithm is Nakamoto Consensus. For Ethereum, it is known as Ethhash.
Nakamoto’s consensus requires waiting for the creation of several additional blocks to ensure transactions cannot be reverted. As a result, Nakamoto chains have high uptime (they do not go down or stall) but low transaction speed due to their probabilistic finalization guarantee. This is because Nakamoto Consensus requires waiting for “enough” blocks to be mined on top of the block that includes the user’s transaction that reorganizing or reverting the blockchain becomes economically impractical, ensuring some “economic certainty” but never theoretic/deterministic certainty.
One issue with allowing anyone to participate in the consensus of an open network is that one malicious actor can create endless nodes, thereby creating multiple identities, as seen by the blockchain. If one person could create enough nodes, they could theoretically control the network, known as a Sybil attack. For this reason, blockchains also need a Sybil Resistance mechanism in addition to its Consensus algorithm.
A Sybil resistance mechanism, on the other hand, is the process through which a decentralized system deters Sybil attacks. A Sybil assault occurs when a single node can flood the network with several identities and utilize them to obtain an outsized amount of power.
Ideally, each node in a decentralized system would represent one vote. If a node can impersonate multiple other nodes and get 100, 1,000, or more than 10,000 votes instead of one, then the system is vulnerable to assault. Sybil attacks are often deterred by requiring nodes to show proof of a difficult-to-fake resource (unlike online identities, which are easy to forge).
Proof of Work - Hash power (e.g., Bitcoin)
Proof of Stake - Tokens (e.g., Cosmos, Polkadot, Tezos)
Proof of Space-Time - disk space (e.g., Chia, Filecoin, etc.)
Proof-of-Authority - (e.g., Algorand)
Validators
Validators play a crucial role in securing a blockchain network. They ensure the network's integrity by verifying transactions and preventing fraud using their stakes. In exchange for their services, validators receive a percentage of transaction costs and/or newly minted coins. However, if a validator acts dishonestly, their staked crypto can be forfeited. Validators are pivotal in maintaining transaction legitimacy, thus upholding the integrity and seamless functionality of the blockchain. Typically, a smart contract algorithmically selects validators to generate and authenticate new transaction blocks, rewarding them for their contributions.
To participate in staking, users must hold a minimum amount of a specific cryptocurrency and operate a node on the network. A node is a software component that interacts with other nodes on the network to validate transactions and add new blocks to the chain. The larger the stake, the more influence a user has on the network and the greater the rewards they can earn.
Proof-of-Stake (PoS) and delegated PoS (DPoS) are two common types of staking. In a PoS system, validators are chosen by the network based on the amount of cryptocurrency they hold and stake. The more they stake, the greater the likelihood that they will be selected to authenticate a new block. In a DPoS system, validators are elected by the community and represent the interests of stakeholders.
PoS Decentralization
Proof-of-stake blockchains' operational efficiency hinges on the number of stake pools or validators. This aspect is central to the notion of decentralization. The critical question is: how many validators process transactions?
A network operated by a limited group of validators spread across diverse geographies and time zones could indicate a less varied range of operators processing transactions. This situation could inadvertently contribute to centralization if several operators become inactive or opt-out4.
The role of validators is critical in a global computing environment. They execute, validate, and document transactions for a permissionless network of users. By reaching a consensus on the chain of blocks—which represent the network's transaction history—validators play a vital role in ensuring Byzantine Fault Tolerance. This means the network continues to operate correctly even in the face of dishonest or faulty nodes. However, the consensus on liveness, finality, and safety thresholds differs for each network, depending largely on specific consensus algorithms and their implementations.
Validators contribute to the network by staking or committing, the network's native asset. This act serves as a form of security, discouraging actions that could harm the network, such as underperformance or intentional sabotage by threatening financial loss—or "slashing"—to the validator. Validators receive rewards in return for their service, typically a fraction of user fees or network inflation, depending on the network.
Impact of Network Design on Operational Decentralization
The operational decentralization of a network is influenced by several factors, including hardware and upfront capital requirements, ongoing operational expenses, built-in stake delegation mechanisms, and active validator set caps.
The costs of hosting a node and the minimum stake needed to operate a validator can impact the network's decentralization. High expenses can serve as a barrier to entry, potentially limiting the diversity of operators. Similarly, ongoing costs for resource consumption and validator maintenance can affect decentralization. Resource-heavy networks like Solana and NEAR may require more substantial infrastructure, which could encourage validators to favor hosted server solutions over local dedicated infrastructure.
Many networks employ a delegated staking mechanism to encourage broader participation. Token holders can stake to existing validators, increasing their chances of producing blocks and earning rewards. However, this can also lead to risk concentration, especially if a validator attracts a significant amount of stake and subsequently fails.
Active validator set caps can also impact operational decentralization. Networks like Cosmos Hub, for example, require validators to own or attract a substantial number of ATOM tokens to participate in the active validator set, potentially limiting validator diversity.
Operational decentralization is a complex and multifaceted aspect of blockchain networks. Various factors influence who operates validators, where they operate, and how they function. While some networks may exhibit high decentralization in certain aspects, they might be less so in others. Standardized metrics like the Nakamoto coefficient can aid in assessing the degree of operational decentralization across validator infrastructure and operational variables.
A Closer Look at Ethereum
In the case of Ethereum, ETH holders can stake their ETH to help provide crypto-economic security to the network. For this act, stakers receive their proportion of the network’s inflation plus transaction fees. In Ethereum, one must stake 32 ETH to become a validator.
A validator is a person or entity who locks up (stakes) 32 ETH in order to run a validating node and secure the Ethereum blockchain. Validators are “are “entities responsible for ordering and packaging transactions into discrete data structures called blocks, which are then proposed to the network to validate.” This means rather than relying on energy/electricity for security, as is the case in PoW, Ethereum security will rely upon staked capital. With PoS and staking rewards, ETH becomes a productive capital asset with yield as well as money underpinning network transactions and executing smart contracts.
The launch of Ethereum’s Beacon Chain in December 2020 marked an enormous milestone that has been on the roadmap from the early stages of the project in 2015 and has already become the largest, most decentralized PoS blockchain with ~840,000 validators.
There are several different ways a user can stake ETH. The most autonomous and preferred method is to personally run a staking node. However, this requires at least 32 ETH plus some intermediate technical knowledge of the protocol, nodes, and computer hardware.
However, there are other types of staking:
- Centralized exchanges: High trust assumptions. Not your keys, not your coins.
- Staking as a service and LSDs: Non-custodial. Entrusted node operation.
- Pooled staking: Stake any amount, Earn rewards.
